Alexander Hamilton was America’s first Secretary of Treasury under President George
Washington. When he first entered office in 1789, America was an
agricultural nation of just 4 million still broke from its financially
costly victory over the British Empire in the Revolutionary War.
The
states had accumulated relatively massive debts to finance that war,
which mostly remained unpaid. The United States did not even have a
national currency, with Spanish coins still in wide circulation and use.
Steve Forbes explains in his recently published definitive work, Money: How the Destruction of the Dollar Threatens the Global Economy and What We Can Do About It,
“America’s finances were in a state of disarray after the wild
inflation resulting from massive money printing during the American
Revolution.” As a result, “Hamilton faced the challenge of restoring the
economy of the young republic that had been devastated by the
Revolutionary War….”
Hamilton boosted America’s economy first by
advancing legislation for the federal government to assume and pay off
the debts of the states, establishing the foundation for America’s
historic creditworthiness. That was recognized by America’s AAA credit
rating for over 200 years, until 2011 when the relentless spending of
the Obama Democrats led to the first credit downgrade of the nation in
history.
But even more importantly for the nation’s long term economic growth
and prosperity, Hamilton promoted The Coinage Act of 1792, which
established the first U.S. Mint, and fixed the value of the dollar at
$19.39 per ounce. That was devalued slightly in 1834 to $20.67, which
prevailed for 100 years, until President Roosevelt adopted the only
major U.S. devaluation in history during the Depression, to $35 an
ounce. That prevailed until President Nixon took America off the gold
standard in 1971.
Forbes explained the results: “Overnight the
economy sprang to life. Capital poured in from the Dutch and also
America’s former enemies, the British. Barely a century after Hamilton’s
reforms, the United States was the premier industrial power in the
world, surpassing even Great Britain.” He added, “Hamilton’s system of
banking and stable money quickly attracted and generated capital. It
turned the American economy into the leading industrial power in the
world.”
Forbes further explains that while America was under the
gold standard, the economy boomed at an astounding 4% real rate of
economic growth. At that rate, our economy, incomes and standard of
living would double every 17 years. That was the foundation of the
American dream and our historic, geometric explosion into the world’s
leading “hyperpower.”
Forbes adds that in the U.S., “Between 1870 and 1914, real wages more
than doubled even though the country had millions of immigrants
[greatly expanding the supply of labor]. Agricultural output tripled.
Industrial production… surged a jaw-dropping 682%.”
Campaign
poster showing William McKinley holding U.S. flag and standing on gold
coin “sound money”, held up by group of men, in front of ships
“commerce” and factories “civilization”. (Photo credit: Wikipedia)
The question is why did Hamilton understand economics so much better
than the Ivy League poobahs of today, like Paul Krugman, who are more
interested in promoting the socially hip stagnation of socialist
equality than the dynamic economic growth of capitalism.
If only
Colonel Hamilton was alive today, he would be more worthy of the Nobel
prize in economics than at least half of those prize winners living
today.
Great Britain experienced quite similar results under the
gold standard. In 1696, the Enlightenment philosopher John Locke was
joined by the path-breaking scientist and physicist Isaac Newton in
arguing against devaluation in the process of Britain replacing or
“recoining” its debased currency with new, unshaved, fully restored
coins.
By 1717, Newton was Master of the Royal Mint, and he fixed
the British pound to the value in gold of 3.89 pounds an ounce. That
exact same historic value remained the same for more than 200 years,
until 1931.
Forbes notes, “When it tied the pound to gold, Britain
was a second-tier nation. Soon all of that would change.” A century
later, “By the end of the Napoleonic Wars in 1815, Great Britain emerged
indisputably as the world’s major power and global center of
innovation.”
Economic Benefits of the Gold Standard
Fixing a
nation’s currency to gold assures that the currency maintains a stable
long term value, without inflation, or deflation. That enables a
nation’s money to serve as a measure of value, like a ruler measures
inches, or a clock measures time. Such a stable measure of value, in
turn, means money can best perform its most essential function in
facilitating transactions.
When money serves as a stable measure of value, it most clearly expresses the value of everything in terms of everything else.
That
best enables producers to determine whether their production is adding
or wasting value as compared to the value of the inputs to that
production. Or whether they should be producing something else instead
that might create greater value. That information is essential for an
economy to maximize output and economic growth over time.
When a farmer trades his crop for such stable money, he immediately
knows what that crop is worth. And he knows that he can keep that value
of his production in the currency because it will hold its value over
time, until he is ready to buy something with it.
That stability
of the reward for production undisturbed by monetary fluctuations adds
further to the incentive for such production.
Similarly, with a
stable value for money, investors know the money they will receive back
from their investment will be worth the same as the money they put in
it, undepreciated by inflation. That encourages greater savings,
investment and capital formation from within the country. And it
encourages investment and capital to flow into the country from abroad.
This maximizes overall investment, production and economic growth.
Nixon Takes America Off the Gold Standard
On August 15, 1971, President Nixon took America, and the world, off
the gold standard completely, leaving a world of unanchored fiat
currencies, by terminating the postwar Bretton Woods monetary regime.
Nixon
and his advisors mistakenly believed that this would help the economy
by promoting American exports, which Forbes recognizes as 18th century
mercantilist thinking. [It was Roosevelt who took America off the Gold Standard, See the end of Bretton Woods - ED]
But it was a decisive turn for the worse
for the American economy, and the entire global economy. Since that
time, real annual U.S. economic growth has averaged 3%, down 25% from
the prior gold standard long term trend. Forbes explains,
“If
America had grown for all of its history at the lower post-Bretton Woods
rate, its economy [today] would be about one quarter of the size of
China’s. The United States would have ended up much smaller, less
affluent, and less powerful.”
Moreover, “Since 1971, the dollar’s
purchasing power has declined by more than 80%,” with about a third of
that (26%) since 2000. Real incomes have been stagnant, or even
declined. “[A] man in his thirties or forties who earned $54,163 in 1972
today earns around $45,224 in inflation adjusted dollars — a 17% cut in
pay.”
Unemployment has been significantly higher on average. Globally,
“After the 1970s, world economic growth has been a full percentage point
lower; inflation 1.5% higher.”
Forbes observes, “The correlation
between unstable money and an unstable global economy would seem
obvious.” Indeed, the termination of any link between the dollar and
gold immediately inaugurated worsening boom and bust cycles of inflation
and recession in the 1970s, with inflation soaring into double digits
for several years. Inflation peaked at 25% over just two years in 1979
and 1980.
It took the worst recession since the Great Depression
in 1981-1982 to tame that inflation, with double digit interest rates
for years, and unemployment peaking at 10.8%. The
Reagan/Volcker/Greenspan strong dollar monetary policies effectively
restored a discretionary link to gold, with gold stabilizing around $300
to $350 for 20 years. That kept close control over inflation.
But
this discretionary standard broke down as 2000 approached. The Fed
loosened money and reduced interest rates over the Y2K scare,
contributing to the tech stock bubble. Much worse, the Bush
Administration supported a weak dollar monetary policy again on the
mercantilist/Keynesian confusion that would help the economy by
promoting exports.
That included more loose money and 2½ years of
negative real interest rates which served to pump up the housing bubble
and lead, along with Clinton’s wild over regulation (in the name of
affordable housing), to the 2008 financial crisis and recession.
The best thing about Steve Forbes’ new book,
Money, is that
it discusses exactly the specific reforms that should be adopted today
to establish a modern, 21st century link to gold for the dollar. That
new system would not require the federal government to hold any gold
stockpiles, and the money supply would not be limited to the
availability of any quantity of gold.
Federal law would fix the
dollar’s value in gold at a specified market price. That price would be
set by some index to recent market prices for gold, perhaps the average
gold price for the last five to 10 years, marked up by 10% as a hedge
against causing deflation in the process. Federal law would mandate that
the Fed conduct its monetary policy to ensure a stable value of the
dollar at that market price.
The Fed would enforce that price
through its open market operations buying and selling U.S. government
bonds. If the price of gold began wandering in the market above the
specified market price, that would signal the threat of inflation, and
the Fed would begin tightening monetary policy by selling bonds to the
market in return for cash withdrawn from the market.
That reduced
money supply would hold down price increases in the market, including
for gold. The Fed would continue this policy, until the market price for
gold returned to its specified target value.
If the price of gold
began wandering in the market below the specified market price, that
would signal the threat of deflation. The Fed would then begin loosening
monetary policy by printing cash to buy U.S. government bonds in the
market. That would increase the money supply, which would tend to
increase prices in the marketplace, including for gold.
The Fed
would continue this policy until the market price for gold returned to
its specified target value. The Fed would be required by the federal law
to take such actions to prevent the price of gold from varying from the
target price by more than 1%, which was the range permitted under the
Bretton Woods system for currencies to fluctuate against the then gold
backed dollar.
The federal law would provide that this new monetary policy would
become effective at a specific date set in the future, perhaps 12 months
away, to enable the private economy to plan for and adjust to the new
policy. The law should grant the President or some other federal
official the power to adjust the target price for gold to reflect more
recent market prices as the implementation date approaches.
Those
more recent market prices would better reflect what the target gold
price should be when the dollar is based on this new link to gold.
A
lesson learned from experience with President Obama, the law should
also specify that any member of Congress would have standing to sue the
President or other designated official if he or she did not carry out
the law regarding this later market based adjustment as provided, and
that federal courts would have the power to enforce relief. For example,
not following more recent market prices in adjusting the target price
would be a violation of the law.
This would effectively mean that
the Fed would no longer have any power to pursue discretionary monetary
policies to try to guide the economy in one direction or another. The
new federal law would bar the Fed from attempting to manipulate interest
rates, for example.
The Fed would no longer have the power to set
the federal funds rate, which is the rate banks pay to one another to
borrow reserves. The Fed would continue to have the power to act as a
lender of last resort to deal with financial panics that might
temporarily threaten an otherwise sound bank.
So the Fed could
continue to set the “discount rate” that it would charge for such short
term, lender of last resort borrowing. But even that would be required
to be set above market rates, so that the Fed would not become a cheap
source of funds for banks to borrow to lend out.
Along with a
federal balanced budget amendment to the Constitution, this would
effectively make Keynesian economics illegal. That would be highly
desirable, because Keynesian economics is proven not to work, and
Keynesian advocates are so oblivious to reasoned discussion on the
point.
As a safeguard to help ensure that the Fed did follow its
responsibilities under this new law, the law should specify that anyone
could turn dollars into the Fed, and get gold at the legally specified
target price. If the Fed was following the law, it could always buy gold
in the market to pay for such a redemption in return for the target
price for gold.
If the Fed was not following the law, then it
would likely not be able to finance such mandatory redemptions. The new
federal gold law should again specify that any member of Congress would
have automatic standing to sue the Fed to enforce the law.
Another
safeguard would involve removing all barriers to the rise of private,
competing, alternative currencies, to challenge the Fed to enforce and
follow the law. That would mean no taxes, including capital gains taxes,
could be assessed on sales of gold and silver. If the Fed did not
follow the law, then these competing currencies could displace the
dollar.
Such a new gold link to the dollar would be the last,
missing component to any comprehensive strategy to restore traditional,
world leading, American prosperity. Such a strategy would include as
well personal and corporate tax reform to lower tax rates, deregulation
of unnecessary regulatory costs and barriers, reduced federal spending
to balance the budget and reduce the national debt as a percent of GDP,
and free trade.
Those policies could be expected to restore
long-term U.S. economic growth to 4% of GDP, which would leapfrog the
American economy another generation ahead of the rest of the world.
Peter Ferrara is Director of Entitlement and Budget Policy for the Heartland Institute, Senior Advisor for Entitlement Reform and Budget Policy at the National Tax Limitation Foundation, General Counsel for the American Civil Rights Union, and Senior Fellow at the National Center for Policy Analysis. He served in the White House Office of Policy Development under President Reagan, and as Associate Deputy Attorney General of the United States under President George H.W. Bush.
This article is published under a creative commons license here.
